Take five major asset classes: U.S. stocks, international stocks, long-term government bonds, Treasury Bills, and REITs. If their respective compound rate of return over the past two decades is compared, which would come in highest?
Maybe bonds as they’ve ridden yields down to near zero?
REITs win the day.
If returns for these asset classes over the past twenty years are compared, REITs returned the most, leading the way with a compound annual return of 10.4%.
There may be benefits of adding REITs to a traditional investment portfolio beyond historical returns.
Whether it’s farmland, apartment rentals, home builders, or commercial properties, real estate can be a diversifier when combined with a portfolio of equities and fixed income.
Now, when one thinks “REITs,” chances are “income” comes to mind. And many investors stop their analysis right there – which REIT yields the most? We believe this is a limited perspective.
Today, let’s highlight why by walking through what we believe is a more optimal way to structure a REIT portfolio.
Diversification Across the Globe
Across all asset classes, one of the biggest diversification mistakes that investors make – across all asset classes – is concentrating their investments in their own, home country.
For example, if the global stock market is weighted by size, the U.S. only accounts for a little over half of the total market-cap. But most U.S. investors allocate about 80% or more to US stocks.
Of course, this home country bias is not specific to U.S. investors. It exists all over the world and is even more pronounced in smaller countries since they command a much smaller percentage of global market-cap weights.
Only considering U.S. exposure when it comes to REITs could be a mistake.
However, considering global exposure is just the first step in creating balanced, optimized REIT portfolio. There are additional, beneficial steps one could theoretically take.
Incorporating Value, Quality, and Momentum Factors
Most people consider using factor investing when it comes to stocks, but what about REITs?
S&P has built a factor-based index focused on the global REIT sector. This S&P Global REIT Quality, Value & Momentum (QVM) Multi-Factor Index first starts with the S&P Global REIT Index universe. The index then screens for companies with specific attributes related to value, quality, and momentum. Real estate is a unique sector, and the index utilizes factors that are specific to REITs like funds from operations (FFO) and financial leverage levels.
Why would investors want to consider factors such as these when it comes to REITs?
The simple answer is: to break the market-cap weight.
We’ll examine this topic and how a multi-factor REIT approach may fit into a portfolio in Part II…
The views and opinions of any third-party author are his/her own and may not necessarily represent the views or opinions of S&P Dow Jones Indices or any of its affiliates.The posts on this blog are opinions, not advice. Please read our Disclaimers.